You don’t have to pay cash or take out a loan to get yourself in the driver’s seat of a brand new car. Leasing used to be a car buying instrument reserved for corporate customers however as car prices have trended upwards and discretionary income has trended downwards, the lease has become a common tool.
Leasing is often a less expensive way to acquire that new ride you’ve been eyeing and in some cases can even offer some favorable tax advantages. However, leasing isn’t without its drawbacks. Below we’ll examine the pros and cons of leasing versus buying to aide you in making an informed decision.
Pros of Leasing a Car
Let’s get straight to the point – PRICE. One of the biggest differences and reasons why a lot of buyers prefer leasing is because it’s typically cheaper than financing.
Why? When you lease you pay a drive off payment (the same concept as a down payment but is typically less money) and then only pay for the period of time you are using the car, typically 3 years. There is a predetermined value called the residual which is a percent like say 55% which determines what your car will be worth at the end of the lease. Then the difference between the purchase price and the residual is the amount left to be paid for. This is different than financing where you subtract your down payment and then get a loan on the entire remaining balance.
Vehicle Lease – Assume 55% residual
- Vehicle cost = $20,000
- Drive off payment : $1,000
- Balance to be paid: $10,000 ((20,000 *.55) – 1000)
Vehicle Finance – Assume 10% down
- Vehicle Cost = $20,000
- Down payment (10%): $2,000
- Balance to be paid – $18,000 (20,000 – 2000)
2) Tax Deductions!
Do you use your car for your own business? Well if you do leasing offers a great incentive. Because you don’t own the car you can’t depreciate it but you can write off the percentage of your lease payment that you use the car for work.
Example: Your lease payment is $400 per month and you use your car for work 75% of the time. You would be able to deduct $300 per month!
Please remember that a $300 dollar deduction will actually translate to anywhere from $75 to $120 in actual real dollar tax savings depending on your tax bracket. That’s like a 25% discount in your monthly payment!
3) Predictable Cost Of Ownership
Leases last for a definite period of time, typically three years which means your average warranty has you covered over the entire span of your ownership period. You still have to perform basic maintenance like oil changes to avoid extra fees when it’s time to turn in your car but these costs are easy to keep a budget for because you know how many miles you need to go before getting one.
The residual or what the car will be worth at the end of the lease is determined at the time of the lease so if at the end of the term the car is worth less than the residual value (as long as the car is in the proper condition) it’s not your problem and the dealer has to eat that loss
4) If you like having the latest and greatest (who doesn’t?)
Who doesn’t like driving around a car with the newest suite of features that the car manufacturers have come up with? It’s always nice to be driving a car or have a car for your kid that’s equipped with the latest safety features. Plus at the end of the term you don’t need to find a place to trade in your used vehicle.
Cons of Leasing a Car
1) Strict Mileage Limits
Lease contracts impose strict mileage limits on how many miles you may drive the car. The most typical mileage restriction are (per year) 10,000, 12,000, and 15,000. You will typically pay more for a lease with a 15,000 mile per year limit than a lease with a 10,000 mile limit.
Once you passed the mile restrictions, steep fees are added for each additional mile driven. You will typically be asked to pay penalties upwards of .20 per mile. That’s $1 for every five miles!
Every lease comes with its own unique terms and conditions so you must be vigilant in understanding all of your contract. Just because your last lease said one thing doesn’t mean your new lease agreement will say the same thing.
Also, leasing customers must make sure they understand all of the fees associated with their lease contracts. In some cases it’s not just as simple as dropping of your old car and picking up the keys to a new one.
In many cases leasing requires a higher credit score than financing or at least doesn’t serve as wide a range of credit quality as traditional financing.
4) No Equity
When you lease, you’re basically just renting the car for the next couple of years so when your lease term is up you have no equity in the car and nothing to apply to the down payment of your next vehicle. If you decide to purchase the car at the end of the lease, then you may end up paying higher interest rate because you’d be financing the car as a used vehicle rather than a new one.
Pros of Financing a Car
- If You Plan to Own for The Long Haul
If you plan on owning your car for a long period of time, then you may save money in the long run because once your loan has been paid off you no longer have car payments to factor into your budget. Although you may save more with a lease upfront, if you own the car long enough you will likely see greater savings with traditional financing (assuming no major repairs).
- No Mileage Restrictions
Have a long commute to work? Live outside city limits which requires more driving? Where you may violate mileage restriction just based on your every day driving habits financing may be the right option for you.
Cons of Financing a Car
- Up-Front Cost
The down payment requires for vehicle financing typically ranges between 10% and 20% which is more expensive than your drive off payment for a lease. Just as we talked about under the pros of leasing, at least for the first couple of years it will cost you more out of pocket to traditionally finance your new ride.
- Monthly Payment / Down Payment Game
We all do it, well most of us anyway. We try to get the monthly payment to fit our budget so we play with the idea of just lengthening the loan term to minimize our monthly payment.
The problem is that longer loan terms despite being trendier as of late allow your interest a lot more time to compound and because lenders view these longer term loans as risky, the interest rate will already be higher. Longer term limits may seem attractive in a monthly price but you will pay more in the end and are more likely to be under water if you try to trade in your car early because you pay more in interest at the beginning of the loan and more in principal at the end.
- Unpredictable Ownership Cost
Although this con is somewhat less relevant with the vast improvement of auto manufacturing you may still be affected by changing market valuations for your vehicle which won’t impact you on a lease. Moreover, long term ownership which translates to owning the vehicle past the life of its warranties, meaning that you will have to come out of pocket if or rather when your car needs a major service.
It’s important to remember that when it comes to financing or leasing your next new car that there is no one-size-fits-all answer. You have to carefully weigh the costs and benefits involved with each purchasing instrument and determine what makes the most sense given your own unique situation.
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